Criticizing the Third Co-operative Principal (1997)

This document has been made available in electronic format
by the International Co-operative Alliance (ICA)
Oct, 1997
(Source: Co-op Dialogue, Vol.7, No.2, May-Aug. 1997, pp.24-26)

Criticising the Third ICA Principle
by Zvi Galor

During its centennial 1995 Congress in Manchester, The International
Co-operative Alliance adapted a new list of co-operative principles. This
paper refers to the third principle dealing with the relationship between
the members and their co-operatives. The principle can be examined on two
levels - ownership and participation - using variables that reveal what is
wrong with it as it is now, and how it can be changed.

First Variable
The fixed assets of the co-operative:

To whom does the co-operative belong? The usual answer in the
co-operative world is that it belongs to its members. The point of
departure is the assumption that an enterprise belongs to its owners.
In most co-operatives the fixed assets do not belong to members, and
the value of the fixed assets is not expressed in the value of members
shares. This situation results from historical circumstances in western
co-operative thinking. 

The share capital in the co-operative is the basis of the enterprise.
Unfortunately, this notion is understood in different ways in different
countries, which leads co-operatives to make mistakes and fail. In this
context, the share of each member in the co-operative is of equal value,
and the value of all shares capital is exactly the value of the total fixed
assets of the co-operative.

There is another approach used all over the world which explains that
each share capital has a very minimal financial value, and holds this
nominal value throughout the life of the co-operative. The combined value
of member shares is minimal, and represents a very small portion of total
value of the fixed assets of the co-operative. So, to whom does the rest of
the value of the fixed assets of the co-operative belong? The answer offered
by those who support the approach recommended by ICA is not very clear.

Here, another factor interferes. Must share capital in the co-operative be
remunerated? The co-operatives world's answer is yes, but to a limited
extent. Those who favour this approach do not consider the fact that this
approach discourages self-financing of the co-operative by its members,
(which is the cheapest way to mobilise necessary funds), and encourage
financing from external sources which are often very expensive.
Remunerating the share capital of members, generally funded from the
surplus money, means taking money away from members to give to
members.  The argument can be made that share capital should retain
its real value, but should never be remunerated.

Another very important concern is the legal reserve fund, required by
different co-operative legislation around the globe. The reserve fund is often
defined as money to indemnify the co-operative in case of economic disaster. Economic difficulties occur either when the fixed assets of the
co-operative have been damaged and money is needed for repair, or when
the financial year has ended with a deficit the reserve fund is used to cover
it. Where does the money for the reserve funds come from?  The legislation
in many countries and practice in most co-operatives around the world is to
subtract money from the annual surplus of the co-operative earned through
member participation, which can differ individually and from year to year. The two uses of the reserve fund presented earlier must be further analysed.

Damages to fixed assets - If the reserve fund is used to pay for damages
caused to the fixed assets of the co-operative, it creates injustice among
members. Fixed assets are financed by all members equally. Taking from
reserve funds means members who participate more in the business of the
co-operative pay more for these fixed assets, but their level of ownership
remains the same. This is an alarming injustice. 

Covering deficits - Using the money of the reserve funds to cover any
annual losses in the business of the co-operative is also unjust. A deficit
occurs when the co-operative is not applying the real price of its services or
its produce to its clients and members. Using the reserve to cover deficit
punishes participating members by asking them to pay the balance that was
not charged to other members. 

One can argue that members should be charged according to participation,
using the same methods used to collect the surplus fund. If the reserve fund
is to cover damages caused to fixed assets, it should be collected from all
members equally. Co-operatives everywhere are struggling with the
question of what to do with the accumulated reserve fund until it is needed.
Most co-operatives deposit it in banks, where the rate of interest paid is
often below the level of annual inflation. Consequently, the real value of
the money of these funds is eroded, making it insufficient when needed.

Second Variable
The notion of surplus:

The notion of a surplus is also misunderstood by members and leaders of
co-operatives.  The surpluses, by nature, are the margin of security applied
to the on-going operation of the co-operative enterprise. How do
co-operatives use profits? In a private enterprise, the net results are
distributed among investors. The enterprise looks to maximise its net results
to better remunerate their investors. In the co-operative enterprise, surpluses
are distributed among all units of members' participation. Since the "raison
d'etre" of a co-operative is to guarantee to its members the best possible
service at the lowest cost.  The need for member participation negates profit
motivation.  The co-operative approach is a balanced approach which seeks
to refund surplus to members according to patronage.

Co-operatives make many mistakes when dealing with surpluses.  The first
is the practice of dedicating part of the surplus to the fixed assets of the
co-operative, which belong to all members equally.  In this case, some
members contribute more to fixed assets than others without increasing their
share. The assets no longer belong exclusively to members, but become the
property of an abstract entity called non-divided reserves which belong to
nobody. These reserves increase every year, and cause members to behave
indifferently towards their co-operative.

Surplus is also used to finance the education of members. The success of a
co-operative depends to a large extent  on how well members understand
co-operative principles through education.  Yet, financing co-operative
education with surplus creates injustice among members. Two members in
a consumer co-operative provide an example. One has held a membership
for many years and understands co-operative principles. This member has many children, and his economic situation is not very good. He purchases
through the co-operative to feed his family and, by so doing, contributes to
the surplus. Another member joins the co-operative. He is young, without
children, and his economic situation is sound. He purchases few items in
the co-operative, not contributing much to the surplus. 

The co-operative decides to use (reference to Rochdale) the surplus to
finance the co-operative education of its members. The man who has
contributed more to the surplus must now finance the education a member
who has contributed less. This practice exists in most co-operatives all over
the world. Co-operative education - yes - but never from the surplus.

Using surplus to pay the interests on the share capital is enshrined in
co-operative legislation in many countries around the world.  An equal
amount of interest is paid on shares of equal value to all members in the
co-operative finance from a source not created equally by members, but
based on member participation in the co-operative business. Why should a
member who participates more in the co-operative received the same
dividend as a member who participates less. The share capital, which
represents the real value of the fixed assets of the co-operative, should not
be remunerated in any case.

Using surplus to finance reserve funds of the co-operative is also a mistake. 
If a co-operative decides to create a reserve fund as a way to safeguard its
real value, it should be financed by all members equally.

Profit-oriented co-operatives in many countries falsely believe that a surplus
is proof of success. A co-operative is created by and for its members.  The
best possible service means minimising the surplus by reducing the cost of
member participation.  There are two types of members; those who use the
co-operative and those who don't.

Consumer co-operatives, savings and credit co-operatives, housing and
insurance co-operatives are characterised by the fact that their members are
not employed in the co-operative,  the value of share capital is relatively
low, and the number of members is not limited. Members are not users in service and producer co-operatives, transport co-operatives, construction
and other co-operatives. These are characterised by the fact that their
members are employed in the co-operative, the value of the share capital is relatively high, and the number of members is limited to the employees.

What is quality service for members in these different types of co-ops?
In the consumer co-operative, providing the best possible quality and at
the lowest possible price is good service. In the saving an credit
co-operatives, the highest possible rate of interest on savings and the
lowest possible rate of interest on loans means good service. In the service
or production co-operatives - the highest return for their work is quality
service. In all of these are examples, the most important element is to
render to members the best possible return. Co-operatives that meet this
challenge have the best chances for survival.

In Israel, there are many co-operatives which follow the approach advocated
in this paper and they are among the successful. The Kibbutz, which is
the co-operative 'trademark' of Israel, today is abandoning its historical
approach of dividing the co-operative from its members in favour of
rendering more to its members. 

This approach may save the existence of Kibbutz. The Moshav, the
transport co-operatives, are practising a model that the co-operative
belongs to its members, and that the members and co-operative property
are the same.

Zvi Galor is the Programme Director at the International Institute-
Histadrut in Israel.